13% Chance Buffett Is Going To Zero

We already mentioned that CDS spreads at Berkshire Hathaway are blowing through the roof on fear that it’ll lose its AAA rating, resulting in a host of calamities. So what exactly is the market telling us? Felix Salmon plugs in the numbers:

There’s another way of looking at Berkshire Hathaway, however, and that’s through the lens of its credit default swaps, which are now trading at a whopping 535bp — pricing in a probability of default which is much greater than one would ever expect from a triple-A company with barely more debt than cash.

If you take those numbers seriously, then maybe the market isn’t valuing Buffett at zero. Remember that historically Berkshire Hathaway has traded on a price-to-book ratio of about 2: if you gave Buffett $100, and he spent that $100 on shares of American Express or Coca-Cola, then the market would value those shares, as owned by Warren Buffett, at $200.

On the other hand, if you plug in a 60% recovery value, the market is saying that there’s a 13% chance that Berkshire Hathaway is going to default at some point in the next five years. (A handy formula for you: the default probability is the CDS spread divided by 1-R, where R is the recovery value.) If Berkshire defaults, the equity will be worth zero.

Of course, as Felix notes, the CDS market could be overdoing things on both Berkshire (and GE, which is suffering from similar default fears). And we suspect that if it gets so bad that Berkshire goes bankrupt, there probably won’t be anyone else left standing, either.